Monday, March 31, 2014

I read libertarian blogs frequently, and one thing I have noticed of late is how some Austrian economists and vulgar Austrians who comment on Austrian/libertarian blogs and are now so embarrassed by the prior predictions of hyperinflation that they deny that Austrians ever made any such predictions.

So is this new denial really true? Did no Austrian economist or Austrian pundit predict hyperinflation?

Austrian: But person x is not a genuine Austrian! [no true Scotsman fallacy].

Critic: But person x supports Austrian economics and uses it in economic analysis and self-identifies as an Austrian.

Austrian: But he is still not a genuine Austrian economist with a degree in Austrian economics! [fallacy of equivocation].

Critic: Well, person y is recognised as an Austrian economist with a degree in that field under another prominent Austrian economist and he predicted hyperinflation too.

Austrian: but person y did not predict hyperinflation as 100% certain, he only said it might happen! [fallacy of equivocation and moving the goalposts fallacy].

Of course, the argument may hinge on the meaning of “predict.” The ordinary dictionary definition of “predict” is to “announce something as an event that will occur in the future” or “say that something will happen”: this could mean either that

(1) the person says the event absolutely will happen with a 100% certainty (in a given time frame), or (more probably)

(2) the prediction that something will happen (in a given time frame) is probable or highly probable and contingent on given conditions (if x and y continue to occur, then z will result).

These are the meaningful senses of the word “predict,” but, as it happens, we have evidence that Austrians predicted hyperinflation in both senses.

We need only look at these examples:

(1) Marc Faber predicted that hyperinflation in the US was 100% certain in 2009

Of course the absurd thing is that Faber gave no time period for his prediction in the video (was it supposed to be within 1 year? 2? 3? 6? 10? 50? 100?), and one need hardly point to how absurd it is for anyone to claim that he is predicting something, but then spectacularly fail to give a time period to limit the prediction and allow it to be tested.

Nevertheless, the context would suggest that Faber was thinking of a short to medium time frame, perhaps 10 years at the most. As of this day, his prediction has failed.

And we should note that in the same video, Peter Schiff made a conditional, probabilistic prediction of hyperinflation too.

(2) Peter Schiff in 2008
In this interview from April 21, 2008:

“[sc. Interviewer]: What is your long-term, 20 year outlook on the health and durability of the American economy as a whole? Will the combination of new regulations, welfare liabilities and inflationary pressure create a prolonged recession similar to what Japan has undergone since the early ’90s?

Peter [Schiff]: I am not sure. The road ahead will be filled with many potholes and include some important forks. Since I do not for sure which ones we will follow, I prefer to invest abroad until our path is more certain. As it stands now, we are headed to a hyperinflationary depression. I hope we will choose a different path before we actually get there.” Tim Swanson, “Interview with Peter Schiff,” Mises Economics Blog, April 21, 2008.

In the full interview, Schiff explicitly states that he supports Austrian economics (he says: “Austrian economics is economics, period!”). Although Schiff’s time frame was in the context of a 20 year period, what is interesting here is that this was before the turn to QE in about December 2008: already around April 2008 Schiff was predicting hyperinflation in a probabilistic sense.

And we have already noted that Peter Schiff made a conditional, probabilistic prediction of hyperinflation too in 2009 in the video above.

(3) Doug French in 2009
In this Mises Daily article:

“So instead of allowing the market to provide a healthy cleansing deflation, the Fed, the Treasury, and bank regulators are fighting valiantly to keep the fractional-reserve-bubble machine operating, with the ultimate result likely to be inflation and possibly hyperinflation.
http://mises.org/daily/3653 Doug French, “Store ’em If You Got ’em,” Mises Daily, August 17, 2009.

Even though his statement about hyperinflation is far less strident and only a possibility, one must question how he could have mentioned it as a serious possibility without at the same time thinking it was at least probable.

(4) Gary North in 2012
Gary North raises hyperinflation as one of two possibilities, presumably both of which he thought were probable:

“The Federal Reserve and its allies — virtually the entire intellectual class — use this fear to maintain its position as the quasi-public bureaucracy in charge of America’s money. It lured the nation into the lobster trap of debt — debt undergirded by Federal Reserve fiat money and congressional deficits — and the country cannot see a way to get out on a pain-free basis. There is no pain-free escape, as we will find over the next two decades: hyperinflation or the Great Deflationary Default or both.

(5) Ron Paul in 2011
Details in this article here. In an interview from 2011, Paul predicts the collapse of the US dollar and hyperinflation, presumably in a probabilistic sense.

Nobody can doubt Paul’s credentials as a supporter and advocate of Austrian economics:

“Paul is a proponent of Austrian School economics; he has authored six books on the subject, and displays pictures of Austrian School economists Friedrich Hayek, Murray Rothbard, and Ludwig von Mises (as well as of Grover Cleveland) on his office wall.”
http://en.wikipedia.org/wiki/Ron_Paul#Political_positions

So from (1) to (5) above we have predictions of hyperinflation as a 100% certainty (Faber in no. 1), to hyperinflation (apparently) as a serious probability (no. 2, no. 4 and no. 5) to hyperinflation at least a serious possibility (3).

The idea that Austrians never predicted hyperinflation in any sense is outrageous, mendacious and contemptible rewriting of history.

Saturday, March 29, 2014

Stahl (2005) reports the results of a survey on price setting behaviour by German manufacturing firms (see also Stahl 2007).

The survey was conducted in 2004 by the Ifo Institute for the Deutsche Bundesbank (Germany’s central bank) and involved 1200 manufacturing firms (Stahl 2005: 9–10).

The firms were asked how prices are determined. The results were as follows:

Constant mark-up on calculated unit costs | 4%
Taking calculated unit costs as a reference and varying the mark-up | 69%
Taking the price of the main competitor as a reference | 17%
Tying the price to another price | 2%
Other | 7%
(Stahl 2005: 10).

Mark-up pricing accounts for 73% of price setting – a very high percentage. Stahl (2005) argues that those firms that set a constant mark-up on unit costs are the mark-up price leaders: the most powerful firms that determined the price in a given market (Stahl 2005: 11). By contrast, time-varying mark-up pricing is used by firms which follow price leaders and must pay more attention to market conditions and competition (Stahl 2005: 11).

Even in the case of the third category (“taking the price of the main competitor as a reference”), it may be the case that these are “price followers” and although less powerful than other mark-up price setters, some of them may also be using mark-up pricing.

When asked what theories best explain price stickiness, the following results were obtained from the most important to least important:

The failure to include cost-based pricing as a theory in this list is a serious oversight, but the results are in line with other surveys: both (1) explicit (and implicit) contracts and (2) coordination failure (the fear that if prices were raised, competitors will not follow suit, and if prices were reduced, then this would set off a destabilising price war) are fundamental factors that restrain prices.

In questions asking about what causes price changes, the following result strongly confirms the important of cost-based pricing:

“It turned out that the most important motivation for price changes is changes in the costs of materials … . Their impact is larger for price rises than for price reductions.” (Stahl 2005: 14).

This also means that prices are more flexible upwards than downwards, and confirms that there is a bias towards upwards movements (rather than downwards movements) in mark-up pricing changes.

BIBLIOGRAPHY
Stahl, Harald. 2005. “Price Setting in German Manufacturing: New Evidence from New Survey Data,” ECB Working Paper Series No. 561
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=868433

Friday, March 28, 2014

Loupias and Ricart (2004) report the results of a survey on price setting behaviour by French firms (see also Loupias and Ricart 2007).

The survey was conducted during the winter of 2003–2004 by the Banque de France and involved 1,662 manufacturing firms (Loupias and Ricart 2004: 8).

In line with other surveys, it was found that it is difficult to question firms about their marginal costs (since the concept is hard to explain to business people!) and marginal cost is itself difficult to calculate (Loupias and Ricart 2004: 11).

As a substitute for marginal cost, the survey instead asked firms about their unit variable costs, and 36% of firms reported that their unit variable costs are constant (Loupias and Ricart 2004: 11).

Firms were asked how many times they changed the prices of their main product in 2003, and the following results were found:

Most firms, then, only changed their product price once in the previous year, and a significant 21.1% not at all, which indicates a high level of relative price rigidity.

Furthermore, prices are more likely to rise than fall: price increases accounted for around 70% of price changes in 2004 (Loupias and Ricart 2004: 25). This is explained by a clear price asymmetry: prices are more rigid downward than upward when cost shocks occur, but when demand shocks occur more rigid upward than downward (Loupias and Ricart 2004: 26, 28–29). That is to say, many firms, when their costs decline, merely prefer to leave prices unchanged (Loupias and Ricart 2004: 27) and enjoy a higher profit mark-up, rather than cut prices.

The firms were asked how they set the price for their main product. The results were as follows:

Though mark-up pricing is reported only at 36.9% (which is lower than findings from other national surveys), it seems clear that the “competitors’ prices” category also conceals other mark-up prices too, as mark-up pricing firms which follow “price leaders” often tend to report their pricing strategy in this category (as the evidence from Ireland and Norway suggests).

When asked to rank the importance of ten theories explaining why prices change and do not change, by scoring them from 1 (unimportant) to 4 (very important), the following results were obtained with theories ranked from the most important to least important:

Although there is evidence that considerably more French firms respond to demand shocks than in other countries (Loupias and Ricart 2004: 27), nevertheless one can note the “demand shock” was not very high on the list.

Thursday, March 27, 2014

A. J. Ayer’s Language, Truth and Logic (1936; 2nd edn. 1946) was a highly influential statement of logical positivism in the English-speaking world, published in 1936 and written after Ayer’s time in Vienna learning from the original logical positivists such as Moritz Schlick (1882–1936), Rudolf Carnap (1891–1970), and Otto Neurath (1882–1945) (though Ayer had met Rudolf Carnap on a trip to Prague, since Carnap had moved there in 1931).

In Chapter IV, Ayer deals with a priori knowledge, and his views are still of some interest, not only for their own sake, but also because there is confusion about what logical positivists thought about a priori knowledge and analytic statements.

For Ayer, propositions with “factual content” are essentially synthetic propositions, and synthetic propositions never have necessary and universal truth, but only probable truth (Ayer 1971 [1936]: 64–65, 80).

So how, then, does the logical positivist account for the truths of mathematics and logic?

Ayer made it clear that he regarded Mill’s belief that the truths of mathematics and logic were merely very well confirmed inductive generalisations to be unconvincing (Ayer 1971 [1936]: 67).

Ayer’s answer is of course that the truths of mathematics and logic are analytic propositions (Ayer 1971 [1936]: 71).

Kant had famously defined analytic propositions as those where the sense of the predicate is already contained in the sense of the subject.

But Ayer used an extended definition of analyticity as the key to establishing the epistemological insight that maths and logical truths are analytic. For Ayer,

“a proposition is analytic when its validity depends solely on the definitions of the symbols it contains, and synthetic when its validity is determined by the facts of experience.” (Ayer 1971 [1936]: 73).

An analytic proposition is thus “entirely devoid of factual content” (Ayer 1971 [1936]: 73) in the sense that it says nothing necessarily true about empirical reality, and so no experience is able to refute it.

“When we say that analytic propositions are devoid of factual, content, and consequently that they say nothing, we are not suggesting that they are senseless in the way that metaphysical utterances are senseless. For, although they give us no information about any empirical situation, they do enlighten us by illustrating the way in which we use certain symbols. Thus if I say, ‘Nothing can be coloured in different ways at the same time with respect to the same part of itself’, I am not saying anything about the properties of any actual thing; but I am not talking nonsense. I am expressing an analytic proposition, which records our determination to call a colour expanse which differs in quality from a neighbouring colour expanse a different part of a given thing. In other words, I am simply calling attention to the implications of a certain linguistic usage. Similarly, in saying that if all Bretons are Frenchmen, and all Frenchmen Europeans, then all Bretons are Europeans, I am not describing any matter of fact. But I am showing that in the statement that all Bretons are Frenchmen, and all Frenchmen Europeans, the further statement that all Bretons are Europeans is implicitly contained. And I am thereby indicating the convention which governs our usage of the words ‘if’ and ‘all’.

We see, then, that there is a sense in which analytic propositions do give us new knowledge. They call attention to linguistic usages, of which we might otherwise not be conscious, and they reveal unsuspected implications in our assertions and beliefs.” (Ayer 1971 [1936]: 73–74).

So the logical positivist view is that analytic a priori propositions are

(1) not meaningless or nonsense as “metaphysical” propositions were presumed to be;

(2) do have real meaning and sense, and

(3) could and do provide human beings with “new knowledge,” such as revealing “unsuspected implications in our assertions and beliefs.”

In sense (3), Ayer was clear that a priori reasoning from analytic statements can yield new knowledge: what Ayer was denying here was that analytic a priori reasoning gives us necessarily true knowledge of the real, external world.

Wednesday, March 26, 2014

Aucremanne and Druant (2005) report the results of a survey of price setting behaviour by Belgian firms (see also Aucremanne and Druant 2007).

The survey was conducted in 2004 by the National Bank of Belgium and involved 1,979 firms in the industrial, construction, trade and services sectors, in a sample that should represent about 60% of Belgian GDP (Aucremanne and Druant 2005: 8, 10).

Under normal conditions, 65.7% of firms used time dependent price setting (Aucremanne and Druant 2005: 25), and of these 60% reviewed prices once a year, and 20% twice a year (Aucremanne and Druant 2005: 28).

It was further found that 55% of firms actually changed prices once a year, 18% less often, and 27% more than once a year (Aucremanne and Druant 2005: 31).

In line with other surveys, it was found that the two major price setting methods were (1) prices set based on costs plus mark-up and (2) prices based on competitors’ price (with the profit margin not determined directly by the company) (Aucremanne and Druant 2005: 22). The way in which this question was asked confirms that the category “competitors’ prices” on other surveys tends to be conceal mark-up pricing.

A clear problem with these types of surveys can be seen in the fact that Aucremanne and Druant (2005) do not ask firms explicitly whether they set their mark-up over total average unit costs or marginal costs (Aucremanne and Druant 2005: 18).

Nevertheless, the firms were also asked to score the importance of theories explaining price stickiness in the following way:

The results of this question, however, are clearly flawed by the failure to even include “mark-up pricing” as a theory, despite the survey finding that this was important in price setting.

But the result that many firms report relatively flat variable cost curves over the business cycle is important (Aucremanne and Druant 2005: 35), and confirmed by other surveys.

BIBLIOGRAPHY
Aucremanne, Luc and Martine Druant. 2005. “Price-Setting Behaviour in Belgium. What can be learned from an ad hoc Survey?,” ECB Working Paper Series No. 448
http://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp448.pdf

Monday, March 24, 2014

Kwapil, Baumgartner and Scharler (2005) report the results of a survey of price setting behaviour by Austrian firms (with a summary in Kwapil, Baumgartner and Scharler 2007).

The survey was conducted in January 2004 by the Austrian Institute of Economic Research (WIFO) and 873 firms participated, which were mainly in the manufacturing and manufacturing-related services sectors, and often producing intermediate goods (Kwapil, Baumgartner and Scharler 2005: 9–11). Of these firms, 715 had direct control over their price setting policy (rather than a parent company), so that Kwapil et al.’s analysis was restricted to these firms (Kwapil, Baumgartner and Scharler 2005: 11). The firms were asked about price setting involving their main product or service.

Around 68% of the firms generally used time-dependent pricing, and carried out price reviews at regular time intervals (Kwapil, Baumgartner and Scharler 2005: 14).

Furthermore, the percentages for firms reporting a specific time interval in time-dependent pricing are as follows:

The firms were also asked how often they changed prices on average in a given year. The results were as follows:

No change | 22.1%
Once a year | 54.2%
2 to 3 times a year | 13.9%
(Kwapil, Baumgartner and Scharler 2005: 18).

The main finding, then, is that the median firm in the survey reviewed its prices quarterly but only adjusted its prices once a year.

Firms were also asked to rank 11 different theories of why prices are generally inflexible by assigning each theory a score from 4 (strong agreement as important) to 1 (disagreement that it was important).

The importance of cost-based pricing was confirmed in another question about what were the main factors in driving prices upwards. It was found that 83% of firms said wage costs and 70% said costs of intermediate goods were the most important factors causing price increases, but changes in demand scored only about 25% (Kwapil, Baumgartner and Scharler 2005: 29–30).

The most important factors driving price decreases were changes in competitors’ prices (57%), productivity improvement (44%), and prices of intermediate goods (41%), but changes in demand scored only about 30% (Kwapil, Baumgartner and Scharler 2005: 29–30).

Cost-based pricing appears to have the consequence that prices are more flexible upwards than downwards when cost shocks occur (Kwapil, Baumgartner and Scharler 2005: 34).

It was further found that 63% of firms would leave their prices unchanged in response to a large positive demand shock, and 52% would leave prices unchanged in response to a large negative demand shock (Kwapil, Baumgartner and Scharler 2005: 33). In the face of small demand shocks (either positive or negative), 82% of firms simply leave prices unchanged (Kwapil, Baumgartner and Scharler 2005: 33).

Kwapil, Baumgartner and Scharler (2007: 63) also reports that 60 to 80% of firms reported that they react to demand shocks (whether perceived to be temporary or permanent) by simply adjusting investment and the level of factor inputs, not prices. This is strong confirmation of the Keynesian view that most firms react to demand changes by directly altering employment and production levels.

Sunday, March 23, 2014

The notion that China is trying to back its currency (the RMB) with gold, in some effort to create a convertible RMB gold standard, is a bizarre libertarian fantasy that you can see on their blogs.

First, what do they mean by “back”? Do they mean China will back its currency 100% with gold? Or just 60% or 50% or 40%?

Since most of the “hard money” libertarians want 100% gold backing to money, it is difficult to see how they would be satisfied with anything except something close to 100% backing.

But a question occurs: is there even enough gold in the world to back the RMB with gold?

According to this, China’s broad money supply (M2) reached 113.18 trillion RMB by February 2014, or about $18.18 trillion US.

Unfortunately, the total value of world gold supply as of August 2013 – even at what many think are inflated prices – was about $9 trillion. I am assuming from this graph that the total value of world gold supply today would be somewhat less than $9 trillion.

Nevertheless, even at the August 2013 gold price, China would have to buy up every single piece of gold in the world, including bullion, gold coins, and gold jewellery, to back just 49.50% of its total broad money supply.

A far more conservative estimate here suggests that official government holdings of gold in China as of this year might be about 2,700 tonnes: that is, worth about $110 billion US. This, however, is less than 3% of China’s foreign exchange reserves.

With $110 billion US worth of gold, China currently has enough gold to back just 0.006% of its total (M2) money supply.

Of course, a massive effort to buy up the world’s gold supply would raise the price of gold, but about 20–25% of gold stock is held by Western central banks, and they are not going to sell their gold to China any time soon.

And if China really made a move to start buying up massive supplies of gold, it is likely that a concerted Western foreign and strategic policy (probably including Japan) would quickly counter it.

All in all, the notion that China could ever back more than small fraction of its currency in gold is a fantasy.

Saturday, March 22, 2014

Updated: in the original post I caused confusion by not properly distinguishing total money from broad money supply.

By “bank money” I mean the type of “credit money” represented by demand deposits and demand deposit-like accounts, such as checking accounts, transactions accounts and even some (so-called) savings accounts.

This credit money forms part of the broad money supply.

In general money supply measures can be divided into two categories (with the example below using the US money supply aggregates):

(1) High-powered money (= monetary base, base money, M0)
The “money base” consists of currency in circulation and bank reserves (both required and excess reserves). The monetary base includes all cash and coins, even vault cash at banks, as well as deposits that banks hold at the Fed (which are reserves).

M1 excludes vault cash and bank reserves at the central bank. “Demand deposit” money can also be called “book money” or “bank money.”

When cheques, debit cards, electronic funds transfer at point of sale cards (EFTPOS or UK “chip and PIN” cards) are used in purchases, this is an example of a sale made by means of bank money. Although final clearing between banks is effected by transfers of high-powered money (which, because of information technology, happens much faster these days than in the past when people used cheques), nevertheless the “bank money” or “demand deposit” money is used extensively in everyday transactions.

But how is bank money created and destroyed? The process is obscured by the way “broad money” aggregates (like M1 or M2) exclude vault cash and bank reserves at the central bank.

But some examples of how bank money is created and destroyed can be made clearer in a simple model:

(1) Method 1:
When a person “deposits” cash in a bank account, this creates bank money, because the demand deposit increases while the actual cash is transferred to become part of the bank’s reserves. Of course, if the cash was “withdrawn” from another bank account, bank money will be destroyed there, but will be created again when the cash is “deposited” in the new account.

To see this, think of an economy with $120 million of total money, as follows:

(1) High-powered money: $20 million;

(2) Bank Money: $100 million.

(3) Total Money: $120 million.

Now if a person with a demand deposit “withdraws” $1 million in cash from a bank:

(1) High-powered money: $20 million (possession of $1 million in cash transferred from a bank vault cash to a person);

(2) Bank Money: $99 million (decreases by $1 million);

(3) Total Money: $119 million.

Now the person deposits this $1 million in cash into a bank account:

(1) High-powered money: $20 million ($1 million in cash transferred back to a bank’s vault cash)

(2) Bank Money: $100 million (increases by $1 million).

(3) Total Money: $120 million.

(2) Method 2:
When money is paid into a bank account electronically from another bank account, this will destroy broad money in latter case and create broad money in the former demand deposit. Of course here broad money will be destroyed and recreated quickly or simultaneously so that it nets out to zero quickly.

(3) Method 3:
When a bank grants credit by creating a new demand deposit it creates new broad money: again think of an economy with $120 million of total money, as follows:

(1) High-powered money: $20 million;

(2) Bank Money: $100 million.

(3) Total Money: $120 million.

Now a bank creates a new demand deposit by granting credit of $1 million:

(1) High-powered money: $20 million;

(2) Bank Money: $101 million (increases by $1 million);

(3) Total Money: $121 million.

In Method 3, it may be that the central bank will eventually have to create new reserves (or high-powered money) when banks need more for clearing, but here we see how even base money creation is driven by the private sector demand for it.

I also hasten to point out that because of the technical way that broad money aggregates are generally calculated (to exclude bank vault cash and bank reserves at the central bank), method 1 does not technically cause an increase in broad money supply aggregates, because cash held by the public is reduced as it is transferred to bank vault cash (so that changes in both bank money and cash held by the public net to zero).

Friday, March 21, 2014

We have already seen in the last post that the vulgar Austrian or libertarian objection to GDP – merely on the basis of it being an aggregate per se – is utterly absurd, and indeed leads to the destruction of Say’s law and all private sector attempts to calculate costs, sales, profit and loss.

So what are the other Austrian objections to GDP? For clarity, let us remember that GDP is the following:

GDP = C + I + G + (X–M)
where
C = aggregate of the sale price of final consumer goods and services;

G = government spending including final consumption expenditure by government and government gross capital formation such as infrastructure investment or research spending (transfer payments are not included in government purchases);

X–M = exports minus imports.

First, it is not even clear that all Austrians reject GDP at all. In fact, there is no universal and orthodox Austrian position on GDP.

Frequently, you find Austrians who cite and use GDP in a way that presupposes that they must accept it as a meaningful and valid aggregate.

At other times there is an implicit use of GDP made in arguments by Austrians. For example, when Austrians claim that the US recession of 1920–1921 and other recessions before 1929 ended “quickly,” they implicitly rely on real GDP data:

“… the 1920–1921 depression was short-lived that most Americans today are unaware of its existence” (Murphy 2009: 71).

“Generally speaking, most depressions (or ‘recessions’ as they came to be redefined after the New Deal) in U.S. history were over within two years, and all of them within five …. Krugman’s ‘explanation’ for the stagnant investment of the 1930s can’t explain why the U.S. economy managed to quickly recover from all of the earlier depressions in its history.” (Murphy 2009: 112–113).

If Austrians, however, think real GDP data is invalid, then they would need to defend such statements above with other data to justify the claims they make. But what real output measure can they use without GDP?

Rothbard’s Gross Private Product is nothing more than GDP, with G removed. That is to say, Rothbard’s Gross Private Product is merely this:

GPP = C + I + (X–M).

This is an aggregate of aggregates too: the total money value of final consumer goods and total value of gross investment (new housing, replacement purchases, net additions to capital assets and investments in inventories), and exports minus imports. If Rothbard’s Gross Private Product is to be taken seriously, then it must be legitimate to aggregate the value of C, I, and (X–M).

But why does Rothbard exclude government spending?

The explanation is here:

“The Department of Commerce method fallaciously assumes that the government’s ‘product’ is measurable by what the government spends. On what possible basis can this assumption be made?

Actually, since governmental services are not tested on the free market, there is no possible way of measuring government’s alleged ‘productive contribution.’ All government services, as we have seen, are monopolized and inefficiently supplied. Clearly, if they are worth anything, they are worth far less than their cost in money. Furthermore, the government’s tax revenue and deficit revenue are both burdens imposed on production, and the nature of this burden should be recognized. Since government activities are more likely to be depredations upon, rather than contributions to, production, it is more accurate to make the opposite assumption: namely, that government contributes nothing to the national product and its activities sap the national product and channel it into unproductive uses.

In using ‘national product’ statistics, then, we must correct for the inclusion of government activities in the national product.” (Rothbard 2009: 1293).

At the heart of this is nothing more than an implicit moral argument: that government taxation is wrong and hence government spending covered by taxes is a “burden … on production” and a “depredation.”

With the ethical basis for Rothbard’s critique of government in ruins, the economic ones need not detain us.

This economic objection consists of the idea that

(1) “governmental services are not tested on the free market” and are

(2) “monopolized and inefficiently supplied” and therefore

(3) “worth far less than their cost in money”.

But the “free market” that Rothbard invokes here, however, is a pure fantasy world of no interest to empirical economics. Rothbard’s belief that something monopolised by government will be inefficiently supplied is only based on his flawed theory that a free market will determine prices by supply and demand, tend to find an equilibrium (or market clearing) price, that price will tend to be equated towards marginal cost, and that free entry is available for competitors to enter and increase production and decrease prices.

But even for most private sector businesses, these things are untrue, since most of the private sector prefers mark-up pricing, shuns highly flexible pricing and shuns marginal cost as the basis of pricing or production. Use of inventories and excess capacity also severely deter free entry into many markets.

While taxes are certainly a cost to private businesses and individuals, the services provided in return for these taxes – such as law and order, justice, enforcement of contracts, property rights, and public goods in general – are the basis of any functioning market society.

In short, Rothbard’s whole economic critique of government services is just as worthless as his moral critique, and there is no convincing reason why government spending should not be included in GDP.

A second Austrian who has arguments criticising GDP is Mark Skousen. But his critique is even weaker than Rothbard’s, for Skousen needs to accept the validity of GDP for his own critique to work.

In The Structure of Production (1990), Skousen attempted to create a new output statistic: Gross Domestic Output (GDO), as his “Austrian” alternative to GDP. In a later version of The Structure of Production (2007), with a new introduction, Skousen proposed another such measure called the Gross Domestic Expenditures (GDE) aggregate (for details see his paper here).

Skousen defines Gross Domestic Expenditures (GDE) as:

“GDE is defined as the value of all transactions (sales) in the production of new goods and services, both finished and unfinished, at all stages of production inside a country during a calendar year.”
Skousen, Mark. 2010. “Gross Domestic Expenditures (GDE): the Need for a New National Aggregate Statistic,” Economics Working Paper No.113, November, p. 11
http://discovery.ucl.ac.uk/1370604/1/wp113.pdf

That is to say, GDE includes GDP and the former could not be a meaningful measure of output if its component GDP was not!

What Skousen proposes is, then, a second measure of real output in addition to GDP but including GDP, one which includes intermediate input, including factor inputs into capital goods production and consumer goods production.

“[Gross Output] … is a measure of the ‘make’ economy, while GDP represents the ‘use’ economy. Both are essential to understanding how the economy works.

While GDP is a good measure of national economic performance, it has a major flaw: In limiting itself to final output, GDP largely ignores or downplays the ‘make’ economy, that is, the supply chain and intermediate stages of production needed to produce all those finished goods and services.”

“Gross Output fills in a big piece of the macroeconomic puzzle. It establishes the proper balance between production and consumption, between the “make” and the “use” economy …. As Steve Landefeld, director of the BEA, and co-editors Dale Jorgenson and William Nordhaus state in their work, A New Architecture for the U. S. National Accounts (University of Chicago Press, 2006), ‘Gross output [GO] is the natural measure of the production sector, while net output [GDP] is appropriate as a measure of welfare. Both are required in a complete system of accounts.’”
Skousen, Mark. 2013 “Beyond GDP: Get Ready for a New Way to Measure the Economy,” Forbes, December 16
http://www.forbes.com/sites/realspin/2013/11/29/beyond-gdp-get-ready-for-a-new-way-to-measure-the-economy/

While Skousen argues that GDP has the “flaw” that it ignores the productive side of the economy, nevertheless his position, as noted above, ultimately requires him to accept the validity of GDP as a measure of the final goods sector of the economy.

For Skousen the virtue of the Gross Output (GO) aggregate is that it shows that consumption is only about 40% of total annual output and that the value of private investment with intermediate inputs is around 50% of economic activity. Also, Gross Output and its private investment and intermediate input component show more volatility than GDP.

These findings, however, do not refute Keynesian economics or even necessarily contradict anything in Keynesian theory except vulgar misunderstandings and versions of it: for Keynes always argued that private investment is a fundamental part of the economy and more volatile than the consumption component of GDP.

Nor does the large size of the value of intermediate input in production refute the clear evidence that demand and expected demand for final output generally drive production and employment decisions in the private sector.

One could have a debate about the merits of GDP versus Gross Output (GO), but that would be a quite different debate from one rejecting GDP completely, and the new debate would already presuppose, as we have seen, that GDP is at least a meaningful and valid measure of the final goods sector of output.

And, finally, one must note the obvious point that all Austrian substitutes for GDP are themselves... aggregates. Rather curious indeed for school that supposedly dislikes aggregation.

Appendix
Robert Batemarco (1987) discusses Rothbard’s Gross Private Product, and on p. 183 gives a table of US GNP and Gross Private Product for the period 1947-1983.

Skousen, Mark. 2013 “Beyond GDP: Get Ready for a New Way to Measure the Economy,” Forbes, December 16
http://www.forbes.com/sites/realspin/2013/11/29/beyond-gdp-get-ready-for-a-new-way-to-measure-the-economy/

GDP aggregates homogenous money units expressed as numbers that measure the price of a good when sold.

If you cannot meaningfully aggregate the money value of heterogeneous goods, then that has clear consequences:

(1) the aggregate value of factor payments from production in Say’s law and the aggregate money value of the purchasing of produced goods as aggregate demand falls apart: it follows that Say’s law – which Austrians support – is meaningless and invalid.

(2) any private business aggregating the monetary value of its quarterly or annual (i) purchases of factor inputs and (ii) sales of heterogeneous goods to customers, to calculate the value of total costs and sales respectively (and hence profits), must be engaged in meaningless activity too: therefore all calculations of sales and profits fall apart and must be meaningless and invalid.

So Austrians who really want to insistent that GDP is “meaningless” or “illegitimate” on the basis that it is an aggregate per se pay a very high price: they destroy Say’s law and the basis of modern business accounting and the calculation of profit and loss.

But aggregation of the money value of heterogeneous goods is precisely the whole basis of Mises’ theory of economic calculation and profit and loss:

“Capitalist economic calculation, which alone makes rational production possible, is based on monetary calculation. Only because the prices of all goods and services in the market can be expressed in terms of money is it possible for them, in spite of their heterogeneity, to enter into a calculation involving homogeneous units of measurement.” (Mises 1985: 71–72).

“Economic calculation requires homogeneous units that can be manipulated in arithmetic operations. Because money is the general medium of exchange and, as such, the one good that is universally and routinely accepted by market participants, it always constitutes one of the two goods that are exchanged in every market. Consequently, money is the item in which all economic quantities – cost and revenue, profit and loss, and capital and income – are expressed and computed. Economic calculation, therefore, always is and must be monetary calculation, i.e., calculation employing money prices that result, or are expected to result, from actual exchanges.” (Salerno 2010: 469).

Finally, we can see how even Rothbard himself dealt with extremists who denied that even an aggregate measure of the total money supply was possible:

“In his unpublished comment on my article on ‘Austrian Definitions of the Supply of Money’ at the Windsor Castle Austrian conference in September 1976, indeed, Israel Kirzner took the nihilist line that it was impossible to define the supply of money, since it was an aggregative concept. It is, on the contrary, a happy aggregate of homogeneous units, whether of dollars or gold ounces.” (Rothbard 2011: 205, n. 61).

Wednesday, March 19, 2014

A very interesting research paper called “Money Creation in the Modern Economy” has recently been published in the Bank of England’s Quarterly Bulletin (2014 Q1). This paper is notable for its endorsement of endogenous money theory and its citations of Post Keynesian literature.

“In the modern economy, most money takes the form of bank deposits. But how those bank deposits are created is often misunderstood: the principal way is through commercial banks making loans. Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money. The reality of how money is created today differs from the description found in some economics textbooks.” (p. 14).

“... in contrast to descriptions found in some textbooks, the Bank of England does not directly control the quantity of either base or broad money. The Bank of England is nevertheless still able to influence the amount of money in the economy. It does so in normal times by setting monetary policy — through the interest rate that it pays on reserves held by commercial banks with the Bank of England.” (p. 25).
Michael McLeay, Amar Radia and Ryland Thomas, “Money Creation in the Modern Economy,” Quarterly Bulletin 2014 Q1
http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q102.pdf

That is entirely correct, and one could add that even “depositing” cash in your bank account also expands the money supply, because your demand deposit increases while the actual cash is transferred to become part of the bank’s reserves (so new broad money is created).

The epistemological status of the cogito ergo sum proposition and the argument underlying it is a difficult philosophical question, and the specialist literature is vast (for just a sample, see Hintikka 1962; Hintikka 1962; Suter 1971; Sarkar 2003; Williams 2005).

Some modern scholars are inclined to think that Descartes understood the cogito insight not as a formal argument per se, but as an intuition or truth from direct introspection, and this finds support in Descartes’s own statement:

“Now awareness of first principles is not normally called ‘knowledge’ by dialectitians. And when we become aware that we are thinking things, this is a primary notion which is not derived by means of any syllogism. When someone says ‘I am thinking, therefore I am, or I exist,’ he does not deduce existence from thought by means of a syllogism, but recognizes it as something self-evident by a simple intuition of the mind. This is clear from the fact that if he were deducing it by means of a syllogism, he would have to have had previous knowledge of the major premiss ‘Everything which thinks is, or exists’; yet in fact he learns it from experiencing in his own case that it is impossible that he should think without existing. It is in the nature of our mind to construct general propositions on the basis of our knowledge of particular ones.” (Descartes, Second Replies).

But intuition or direct introspection should most probably be considered a form of a posteriori knowledge: after all, any conscious thought or perception you have is a form of direct experience.

So the cogito argument is not an a priori syllogistic argument.

But does it have necessary truth? Descartes thought so, and said so in the Meditations:

“… this proposition: I am, I exist, whenever it is uttered from me, or conceived by the mind, necessarily is true.” (Meditation II).

If the justification for the cogito is not a priori, does it show that there are necessary a posteriori truths?

Although modern analytic philosophy, following Saul Kripke, admits the existence of ontologically necessary a posteriori truths, nevertheless the skeptical argument against both the necessary ontological and epistemological truth of the cogito in the form that Descartes proposed it seems convincing.

The crucial problem is Descartes’s claim that an “I’ exists, and that mere conscious experience allows one to infer an existing “I.” The “I” must be understood as a discrete conscious entity and perceiving subject that perceives objects of perception.

But that there is a discrete entity and perceiving subject that we each personally refer to as “I” does not necessarily follow from the cogito, as many skeptics and critics of Descartes have pointed out. What if what exists just consists of thoughts, sensations and perceptions with no discrete, perceiving subjects?

At most, what seems to be certain from direct experience is that kinds of perception, sensation or thinking exist or are occurring, not that any discrete subject exists or is perceiving.

If one takes this as the ultimate inference to be made from direct conscious experience – that kinds of perception, sensation or thinking exist – then perhaps that is a necessary a posteriori truth. Even if one were to concede this, it does not take one very far, however. In fact, Descartes had to prove the existence of god just to reconstruct a new apriorist epistemology, once he had torn down his previous one through the Cartesian method of doubt.

To order to reconstruct a secure Rationalist apriorist epistemology – as opposed to a merely probabilistic inductive one – Descartes needed a miracle, a deus ex machina!

Sunday, March 16, 2014

Actually, the analysis below reveals that Mises appears to have misunderstood the logical positivist position to some degree, and that Mises does indeed need synthetic a priori knowledge for praxeology.

First, let us look at this crucial passage from Human Action on analytic a priori inference:

“Aprioristic reasoning is purely conceptual and deductive. It cannot produce anything else but tautologies and analytic judgments. All its implications are logically derived from the premises and were already contained in them. Hence, according to a popular objection, it cannot add anything to our knowledge.

All geometrical theorems are already implied in the axioms. The concept of a rectangular triangle already implies the theorem of Pythagoras. This theorem is a tautology, its deduction results in an analytic judgment. Nonetheless nobody would contend that geometry in general and the theorem of Pythagoras in particular do not enlarge our knowledge. Cognition from purely deductive reasoning is also creative and opens for our mind access to previously barred spheres. The significant task of aprioristic reasoning is on the one hand to bring into relief all that is implied in the categories, concepts, and premises and, on the other hand, to show what they do not imply. It is its vocation to render manifest and obvious what was hidden and unknown before. ….

The real thing which is the subject matter of praxeology, human action, stems from the same source as human reasoning. Action and reason are congeneric and homogeneous; they may even be called two different aspects of the same thing. That reason has the power to make clear through pure ratiocination the essential features of action is a consequence of the fact that action is an offshoot of reason. The theorems attained by correct praxeological reasoning are not only perfectly certain and incontestable, like the correct mathematical theorems. They refer, moreover, with the full rigidity of their apodictic certainty and incontestability to the reality of action as it appears in life and history. Praxeology conveys exact and precise knowledge of real things.” (Mises 2008: 38–39).

So Mises, in the first paragraph, is asserting that aprioristic reasoning “cannot add anything to our knowledge,” according to a “popular” objection, which is a reference to the logical positivism that dominated philosophy in the post-1945 era in Europe and America.

But that was not the logical positivist view at all. To see this, we need only look at the crucial passage of A. J. Ayer’s Language, Truth and Logic (1936; 2nd edn. 1946):

“When we say that analytic propositions are devoid of factual, content, and consequently that they say nothing, we are not suggesting that they are senseless in the way that metaphysical utterances are senseless. For, although they give us no information about any empirical situation, they do enlighten us by illustrating the way in which we use certain symbols. Thus if I say, ‘Nothing can be coloured in different ways at the same time with respect to the same part of itself’, I am not saying anything about the properties of any actual thing; but I am not talking nonsense. I am expressing an analytic proposition, which records our determination to call a colour expanse which differs in quality from a neighbouring colour expanse a different part of a given thing. In other words, I am simply calling attention to the implications of a certain linguistic usage. Similarly, in saying that if all Bretons are Frenchmen, and all Frenchmen Europeans, then all Bretons are Europeans, I am not describing any matter of fact. But I am showing that in the statement that all Bretons are Frenchmen, and all Frenchmen Europeans, the further statement that all Bretons are Europeans is implicitly contained. And I am thereby indicating the convention which governs our usage of the words ‘if’ and ‘all’.

We see, then, that there is a sense in which analytic propositions do give us new knowledge. They call attention to linguistic usages, of which we might otherwise not be conscious, and they reveal unsuspected implications in our assertions and beliefs.” (Ayer 1971 [1936]: 73–74).

We see here that the logical positivist view, as held by Ayer, is that analytic a priori propositions are

(1) not meaningless or nonsense as “metaphysical” propositions were presumed to be;

(2) did have real meaning and sense, and

(3) could and do provide human beings with “new knowledge,” such as revealing “unsuspected implications in our assertions and beliefs.”

In sense (3), then, not even A. J. Ayer denied that a priori reasoning from analytic statements can yield new knowledge: what Ayer was denying was that analytic a priori reasoning gives us necessarily true knowledge of the real, external world.

So Mises was wrong: his positivist opponents did not claim that a priori inference with analytic statements adds nothing to human knowledge.

What they did claim is that a priori reasoning did not yield necessarily true knowledge of the real world. But here Mises clearly disagrees:

“The real thing which is the subject matter of praxeology, human action, stems from the same source as human reasoning. Action and reason are congeneric and homogeneous; they may even be called two different aspects of the same thing. That reason has the power to make clear through pure ratiocination the essential features of action is a consequence of the fact that action is an offshoot of reason. The theorems attained by correct praxeological reasoning are not only perfectly certain and incontestable, like the correct mathematical theorems. They refer, moreover, with the full rigidity of their apodictic certainty and incontestability to the reality of action as it appears in life and history. Praxeology conveys exact and precise knowledge of real things.” (Mises 2008: 38–39).

According to Mises, praxeological reasoning yields

(1) “apodictic certainty and incontestability to the reality of action as it appears in life and history,” and

(2) praxeology “conveys exact and precise knowledge of real things.”

Epistemologically speaking, the only way it can do this is to either

(1) be Kantian synthetic a priori knowledge, or

(2) be the functional and epistemological equivalent of Kantian synthetic a priori knowledge (even if Mises chose not to use the term synthetic a priori explicitly).

But the idea that Mises never linked his epistemology to Kant is utterly untrue.

Why? The reason is that the very term “category” comes from Kant, and Mises’s idea of a “category of action” was clearly inspired by Kantian a priori categories:

“Every theorem of praxeology is deduced by logical reasoning from the category of action. It partakes of the apodictic certainty provided by logical reasoning that starts from an a priori category.” (Mises 1978: 44).

“Following in the wake of Kant’s analyses, philosophers raised the question: How can the human mind, by aprioristic thinking, deal with the reality of the external world? As far as praxeology is concerned, the answer is obvious. Both, a priori thinking and reasoning on the one hand and human action on the other, are manifestations of the human mind. The logical structure of the human mind creates the reality of action. Reason and action are congeneric and homogeneous, two aspects of the same phenomenon.” (Mises 1978 [1962]: 42).

In the last passage, from Mises’s The Ultimate Foundation of Economic Science: An Essay on Method (1962), he is explicitly linking his “category of action” to Kant’s philosophy.

But that necessary truth is arguably de dicto necessity: a necessity that is a property of the argument being an analytic a priori system, where “John” is merely a hypothetical person who is a bachelor by definition. It follows that even the conclusion must be understood as analytic a priori.

But once we assert “John is a bachelor” of a real and specific person in the world, suddenly something important happens: the minor premise “John is a bachelor” becomes synthetic a posteriori, and can only be proved a posteriori, or by experience, empirical evidence and inductive arguments. The truth of the minor premise therefore becomes contingent, not necessary. It can never have apodictic truth, because there must always be some small doubt about its truth: for example, if John says he is unmarried, then he might be lying or delusional (e.g., perhaps he is mentally ill). If public records say John is unmarried, they may be in error or fraudulent. If John’s friends say he is unmarried, then they may also be mistaken or taken in by John’s lies, and so on.

There is no way to obtain absolute and apodictic truth in propositions known a posteriori.

The consequence of this is that the deduction above only has necessary truth when it is strictly understood as an analytic a priori argument and where the logical necessity is de dicto necessity.

When asserted of a real person, the minor premise and the argument can never be proved in the sense of being absolutely true, because we cannot have apodictic truth about a synthetic a posteriori proposition (the minor premise).

The belief that the syllogism has necessary and absolute truth about any concrete real world person is an illusion that arises by merely assuming the world conforms exactly to the assumptions and requirements of analytic a priori argument: we are using words to abolish uncertainty and effectively imposing an unempirical argument on the real world that can only be known a posteriori. In short, we are conflating (1) the analytic a priori with (2) the synthetic a posteriori, when they are strictly separate.

It has become fashionable in modern analytic philosophy to admit the existence of a second type of necessity: de re necessity. Here it is conceived that the possession of a property y by a certain thing x is logically necessity for it to be identified as a certain kind or type x (a type of essentialist argument).

For example, water is necessarily H2O: for a thing to be the substance we call water, it must be by necessity have the property of being physically H2O.

But one can wonder whether this new view that there are necessary a posteriori truths and metaphysical/ontological necessity has gone too far.

Consider the proposition:

Statement 1: water is necessarily H2O.

Conceived as an analytic a priori statement, it has necessary truth.

But let us consider this statement:

Statement 2: This specific real world sample of water is necessarily H2O.

Here we face the skeptical challenge and Hume’s problem of induction: how can you be absolutely certain that what you are looking at is water at all? You may have made some error. It might be something that looks like water but is not physically H2O. Even a scientific analysis of the substance that seems to show that it is chemically H2O could in theory be mistaken or fraudulent. Or a more elaborate sceptical challenge would be: how can you be absolutely certain that anything you have seen now or in the past that you call water really is H2O and not some elaborate trick by Descartes’ demon?

Statement 2 above asserted of a real world thing must simply abolish uncertainty by begging the question and assuming all epistemological problems and challenges can be countered, in much the same way that the original syllogism above when asserted as absolutely and necessarily true of any concrete real world person simply abolishes uncertainty and renders the argument analytic a priori.

One could argue, then, that modern metaphysical (essentialist) necessity remains a property of analytic a priori systems.

Saturday, March 15, 2014

Take as an example some Austrian who says: it is a praxeological and necessary truth about the real world that, if human beings by their actions drive a monetary market interest rate below the equilibrium rate, then this must necessarily result in excess capital investment causing an Austrian business cycle (ABC). I stress that this is more a “vulgar” Austrian view, and the actual Austrian economists could present more sophisticated defence of their theories.

But such a “vulgar” Austrian statement as above has no necessary truth about the real world.

Why? The reason is that it is contingent on many factors, which range from basic epistemological ones (such as number (1) below) to social, institutional and economic ones, as follows:

(1) the very existence of other acting human minds in the first place. No philosopher has succeeded in proving a priori that other minds exist: the best you can do is an inductive argument from analogy, which only has probabilistic truth at best;

(2) the existence of economies with money;

(3) the existence of economies with loans made in money terms;

(4) the existence of economies with loans made in money and with interest made in money terms;

(5) the truth of loanable funds theory as determined by time preference, which is highly doubtful given that monetary interest rates are better explained by liquidity preference.

(6) the truth of the view that demand for credit will equal some alleged stock of loanable funds, and this can be reduced to a simple and reliable function of interest rates determining the quantity of credit demanded as plotted on a demand curve for loanable funds, when the demand for credit is highly complex and contingent on many factors well beyond interest rates, such as, for example, expectations and uncertainty;

(7) in Mises’s early business cycle theory (ABCT) and the classic ABCT of Hayek the existence of a unique Wicksellian natural rate of interest: something whose probability is close to zero given the empirical evidence that real world economies do not and cannot obtain a general equilibrium state;

(8) The early Hayekian versions of the Austrian business cycle theory assume an economy starting from a general equilibrium state and returning towards one, which is something whose probability is again close to zero given that real world economies do not and cannot obtain general equilibrium states.

And this list is far from exhaustive.

The intellectual fraud of the “necessary” truth of Austrian praxeological theories can be demonstrated quite clearly, since a similar list of contingently true requirements could be provided for any praxeological theory of any kind.

Friday, March 14, 2014

The crux of this theory is the neoclassical view of economic rationality.

Keen (2011: 67–70) points to the work of Reinhard Sippel (1997) on consumer behaviour, which appears to demonstrate that the “rational consumer” view of neoclassical economics is empirically unsound.

Sippel tested the “axioms of revealed preference” as formulated by Paul Samuelson (1938a; 1938b), which can be listed as follows:

(1) Completeness:
Given the choice of different bundles of goods which he can compare, a “rational” consumer can either (1) state which bundle of goods A or B he preferred or (2) state he was indifferent between them.

(2) Transitivity:
If a consumer preferred A (a bundle of goods) to B (a different bundle of goods), and preferred B to C, then logically he must necessarily prefer A to C.

(3) Non-Satiation:
This means that more is preferred to less, so that if A has one more unit of goods than B, then A will be preferred to B.

(4) Convexity:
The law of diminishing marginal utility applies to bundles of goods so that a bundle with units of the same good will be less desirable than a bundle with at least one different good. (Keen 2011: 68).

It should be noted that yet another assumption of these axioms, if they are invoked to define rational consumer behaviour, is that any given consumer’s tastes and preferences must be held constant over the relevant time period (Sippel 1997: 1431).

In experiments with 12 subjects and then 30 with a choice of 8 goods and a budget constraint, Sippel found that most subjects did not obey the axioms of revealed preference: 11 out of 12 in the first group were “irrational,” and 22 of 30 in the second group were also “irrational” (Sippel 1997: 1438).

As Keen points out, even in a simplified model of how to create different bundles of goods with discrete units of measurement only, there are over 16.7 million different bundles of goods which could be constructed, and even when the budget constraint is imposed over 1,600 different combinations of goods (Keen 2011: 70–71).

The problem, as Keen notes, is this:

“The neoclassical definition of rationality requires that, when confronted with this amount of choice, the consumer’s choices are consistent every time. So if you choose trolley number 1355 on one occasion when trolley 563 was also feasible, and on a second occasion you reversed your choice, then according to neoclassical theory, you are ‘irrational.’

Nonsense. The real irrationality lies in imagining that any sentient being could make the number of comparisons needed to choose the optimal combination in finite time. The weakness in the neoclassical vision of reality starts with the very first principle of ‘Completeness’: it is simply impossible to hold in your head – or any other data storage device – a complete set of preferences for the bewildering array of combinations one can form from the myriad range of commodities that confront the average Western shopper. With this principle being impossible, any sane person’s shopping behavior will certainly also violate the neoclassical rules of Transitivity and Convexity (and probably Non-satiation as well). But it will be because the neoclassical principles themselves are irrational, not because
the shopper is.

Consider, for example, your regular visit to a supermarket. The typical supermarket has between 10,000 and 50,000 items, but let’s segment them into just 100 different groups. How many different shopping trolleys could you fill if you limited your decision to simply whether to buy or not buy one item from each group?

You would be able to fill two to the power of one hundred shopping trolleys with different combinations of these goods: that’s 1,267,650,600,228,229,401,496,703,205,376 trolleys in total, or in words over 1,000 million trillion trillion shopping trolleys. If you could work out the utility you gained from each trolley at a rate of 10 trillion trolleys per second, it would take you 100 billion years to locate the optimal one.” (Keen 2011: 71–72).

In neoclassical theory “economic man” (homo economicus) when making a rational choice – say, in spending a given income on a basket of goods – will weigh the various choices and choose that basket of goods which best maximises utility.

But it is clear that you have to be omniscient – a type of god-like agent – in order to be “rational” in the neoclassical sense.

Of course, what actually happens in the real world is that any consumer buying a basket of goods cannot do any such thing, for human beings lack the time, ability and computational power in engage in any such real utility maximisation on the basis of an evaluation of all possible combinations of goods.

For Keen, “[t]ruly rational [sc. consumer] behaviour is therefore not choosing the best option, but reducing the number of options you consider so that you can make a satisfactory decision in finite time” (Keen 2011: 72). To do this, habit, convention, custom, and simple rules of thumb are used or even decisions via influence from other people.

A consumer determines what to consume by dividing goods into different categories and arranging them in a hierarchy, the most basic types of goods at the top of the list, and where the highest basic classes of goods are generally considered in isolation.

Following Herbert Simon, human behaviour is perhaps better described as “satisficing” (conducted so as to satisfy the minimum requirements for achieving a particular result), and not “optimising” (Keen 2011: 72).

Thursday, March 13, 2014

David Gordon’s talk here is on Mises’s method and the epistemological justification for praxeology.

But the crux of David Gordon’s lecture (from 41.21) is this: that Mises supposedly thought that praxeology is analytic a priori, and explicitly and clearly said so.

The explicit statement of that is here (from 44.37 in the video):

“Now one point here: and this is a point I must confess. I made a mistake many years ago when I wrote that Philosophical Origins of Austrian Economics book … But I made the mistake. I thought Mises says the truth of economics is synthetic a priori truth.

What do we mean by synthetic? Well synthetic a priori truth would be one that is a priori. We can know it’s true just by thinking about it. … But it would not be one we could just discover to be true just by looking at the implications of the concept. It would be one that’s true … about the world, but not one that’s just true from the nature of the concept.

So, at one time, I thought: ‘oh, well, Mises ... thinks the truths of economics are synthetic a priori, but in fact he doesn’t say that in Human Action. He says they’re tautologies, which would be that they’re not synthetic a priori truth. Whether he’s right to hold that view is another question, but that was his view.”

This belief about Mises is untrue, and stems from the fact that Mises was just a third rate philosopher, and here and there made some unclear statements in his writings (as in The Ultimate Foundation of Economic Science: An Essay on Method, as we will see below), even though the main epistemological justification of praxeology in Human Action is synthetic a priori knowledge.

To prove this, we need only quote and look at the meaning of the following passage and its implications, since this is the passage in Human Action from which Gordon seems to derive this argument above:

“Aprioristic reasoning is purely conceptual and deductive. It cannot produce anything else but tautologies and analytic judgments. All its implications are logically derived from the premises and were already contained in them. Hence, according to a popular objection, it cannot add anything to our knowledge.

All geometrical theorems are already implied in the axioms. The concept of a rectangular triangle already implies the theorem of Pythagoras. This theorem is a tautology, its deduction results in an analytic judgment. Nonetheless nobody would contend that geometry in general and the theorem of Pythagoras in particular do not enlarge our knowledge. Cognition from purely deductive reasoning is also creative and opens for our mind access to previously barred spheres. The significant task of aprioristic reasoning is on the one hand to bring into relief all that is implied in the categories, concepts, and premises and, on the other hand, to show what they do not imply. It is its vocation to render manifest and obvious what was hidden and unknown before.

In the concept of money all the theorems of monetary theory are already implied. The quantity theory does not add to our knowledge anything which is not virtually contained in the concept of money. It transforms, develops, and unfolds; it only analyzes and is therefore tautological like the theorem of Pythagoras in relation to the concept of the rectangular triangle. However, nobody would deny the cognitive value of the quantity theory. To a mind not enlightened by economic reasoning it remains unknown. A long line of abortive attempts to solve the problems concerned shows that it was certainly not easy to attain the present state of knowledge.

It is not a deficiency of the system of aprioristic science that it does not convey to us full cognition of reality. Its concepts and theorems are mental tools opening the approach to a complete grasp of reality; they are, to be sure, not in themselves already the totality of factual knowledge about all things. Theory and the comprehension of living and changing reality are not in opposition to one another. Without theory, the general aprioristic science of human action, there is no comprehension of the reality of human action.

The relation between reason and experience has long been one of the fundamental philosophical problems. Like all other problems of the critique of knowledge, philosophers have approached it only with reference to the natural sciences. They have ignored the sciences of human action. Their contributions have been useless for praxeology.

It is customary in the treatment of the epistemological problems of economics to adopt one of the solutions suggested for the natural sciences. Some authors recommend Poincaré’s conventionalism. They regard the premises of economic reasoning as a matter of linguistic or postulational convention. Others prefer to acquiesce in ideas advanced by Einstein. Einstein raises the question: ‘How can mathematics, a product of human reason that does not depend on any experience, so exquisitely fit the objects of reality? Is human reason able to discover, unaided by experience through pure reasoning the features of real things?’ And his answer is: ‘As far as the theorems of mathematics refer to reality, they are not certain, and as far as they are certain, they do not refer to reality.’

However, the sciences of human action differ radically from the natural sciences. All authors eager to construct an epistemological system of the sciences of human action according to the pattern of the natural sciences err lamentably.

The real thing which is the subject matter of praxeology, human action, stems from the same source as human reasoning. Action and reason are congeneric and homogeneous; they may even be called two different aspects of the same thing. That reason has the power to make clear through pure ratiocination the essential features of action is a consequence of the fact that action is an offshoot of reason. The theorems attained by correct praxeological reasoning are not only perfectly certain and incontestable, like the correct mathematical theorems. They refer, moreover, with the full rigidity of their apodictic certainty and incontestability to the reality of action as it appears in life and history. Praxeology conveys exact and precise knowledge of real things.” (Mises 2008: 38–39).

First, it is quite clear here that Mises is ultimately rejecting the “popular objection” he refers to in paragraph 1: that tautologies cannot “add anything to our knowledge.” So in fact such apparent “tautologies” cannot really be literally tautologies.

When Mises says:

“Nonetheless nobody would contend that geometry in general and the theorem of Pythagoras in particular do not enlarge our knowledge,”

he means more than just that geometrical deduction yields new truths in an analytic a priori system.

What Mises is saying that Euclidean geometry provides real necessary knowledge about the external world, despite being a system of tautologies derived by deduction from the axioms. He is implying that Euclidean geometry is Kantian synthetic a priori knowledge.

Secondly, although it is poorly expressed, Mises appears to be thinking of synthetic a priori knowledge when he says that:

“In the concept of money all the theorems of monetary theory are already implied. The quantity theory does not add to our knowledge anything which is not virtually contained in the concept of money. It transforms, develops, and unfolds; it only analyzes and is therefore tautological like the theorem of Pythagoras in relation to the concept of the rectangular triangle. However, nobody would deny the cognitive value of the quantity theory.”

Mises cannot seriously believe that his monetary theory provides no necessary knowledge of reality, and it seems that he is referring to the synthetic character of these theories by his reference above to “the cognitive value of the quantity theory.”

Next, Mises is very clear in rejecting the analytic a priori character of praxeology when he rejects (1) Poincaré’s conventionalism and (2) Einstein’s view of mathematics as being divided into (a) pure mathematics (which is necessarily true) and (b) applied mathematics (which is only true of the real world contingently).

The final paragraph of Mises clinches my argument:

The theorems attained by correct praxeological reasoning are not only perfectly certain and incontestable, like the correct mathematical theorems. They refer, moreover, with the full rigidity of their apodictic certainty and incontestability to the reality of action as it appears in life and history. Praxeology conveys exact and precise knowledge of real things.” (Mises 2008: 39).

This entails that praxeological theorems are necessarily and absolutely true, and are known a priori, but also yield necessary knowledge of the real world. That is nothing but Kantian synthetic a priori knowledge.

And, finally, if Mises did not think that praxeological theorems were synthetic a priori, why is Mises desperate to defend the existence of synthetic a priori propositions in The Ultimate Foundation of Economic Science: An Essay on Method (1962)?:

“The essence of logical positivism is to deny the cognitive value of a priori knowledge by pointing out that all a priori propositions are merely analytic. They do not provide new information, but are merely verbal or tautological, asserting what has already been implied in the definitions and premises. Only experience can lead to synthetic propositions. There is an obvious objection against this doctrine, viz., that this proposition that there are no synthetic a priori propositions is in itself a — as the present writer thinks, false — synthetic a priori proposition, for it can manifestly not be established by experience.

The whole controversy is, however, meaningless when applied to praxeology. It refers essentially to geometry. Its present state, especially its treatment by logical positivism, has been deeply influenced by the shock that Western philosophy received from the discovery of non-Euclidian geometries. Before Bolyai and Lobachevsky, geometry was, in the eyes of the philosophers, the paragon of perfect science; it was assumed that it provided unshakable certainty forever and for everybody. To proceed also in other branches of knowledge more geometrico was the great ideal of truth-seekers. All traditional epistemological concepts began to totter when the attempts to construct non-Euclidian geometries succeeded.

Yet praxeology is not geometry. It is the worst of all superstitions to assume that the epistemological characteristics of one branch of knowledge must necessarily be applicable to any other branch. In dealing with the epistemology of the sciences of human action, one must not take one’s cue from geometry, mechanics, or any other science.

The assumptions of Euclid were once considered as self-evidently true. Present-day epistemology looks upon them as freely chosen postulates, the starting point of a hypothetical chain of reasoning. Whatever this may mean, it has no reference at all to the problems of praxeology.” (Mises 1962: 5).

In the first paragraph, Mises was still concerned to defend the existence of synthetic a priori knowledge.

However, he was driven, at the same time, to the extreme position that the collapse of Euclidean geometry as synthetic a priori knowledge does not present any epistemological challenge to the synthetic a priori status of praxeology.

This, if nothing else, is breathtaking in its pig-headed unwillingness to reconsider the epistemological status of praxeology given the fall of Euclidean geometry as the paradigmatic case of synthetic a priori knowledge.

But to return to the original point: David Gordon has misinterpreted Mises’s epistemological position, because he has failed to read the relevant passage from Human Action in its entirety and in context.

Finally, it is true that Mises was sometimes confused, and quite lazy in his treatment of the analytic versus synthetic distinction.

The evidence is here in Mises’s The Ultimate Foundation of Economic Science: An Essay on Method (1962):

“Praxeology is a priori. All its theorems are products of deductive reasoning that starts from the category of action. The questions whether the judgments of praxeology are to be called analytic or synthetic and whether or not its procedure is to be qualified as ‘merely’ tautological are of verbal interest only.

What praxeology asserts with regard to human action in general is strictly valid without any exception for every action. There is action and there is the absence of action, but there is nothing in between. Every action is an attempt to exchange one state of affairs for another, and everything that praxeology affirms with regard to exchange refers strictly to it. In dealing with every action we encounter the fundamental concepts end and means, success or failure, profit or loss, costs. An exchange can be either direct or indirect, i.e., effected through the interposition of an intermediary stage. Whether a definite action was indirect exchange has to be determined by experience. But if it was indirect exchange, then all that praxeology says about indirect exchange in general strictly applies to it.

Every theorem of praxeology is deduced by logical reasoning from the category of action. It partakes of the apodictic certainty provided by logical reasoning that starts from an a priori category.

Into the chain of praxeological reasoning the praxeologist introduces certain assumptions concerning the conditions of the environment in which an action takes place. Then he tries to find out how these special conditions affect the result to which his reasoning must lead. The question whether or not the real conditions of the external world correspond to these assumptions is to be answered by experience. But if the answer is in the affirmative, all the conclusions drawn by logically correct praxeological reasoning strictly describe what is going on in reality.” (Mises 1962: 44–45).

Mises’s main epistemological concern is to maintain the a priori status of praxeology.

But his remarkable statement is here:

“The questions whether the judgments of praxeology are to be called analytic or synthetic and whether or not its procedure is to be qualified as ‘merely’ tautological are of verbal interest only.”

According to Mises, whether praxeological theorems or derived theories are “synthetic” or “analytic” is of “verbal interest only.” That is an incredibly ignorant statement, because if praxeological theorems say anything necessarily true of the real world, as Mises says in many other passages (Mises 2008: 39), then they must be synthetic, not analytic.

Mises is logically committed to defending the synthetic a priori status of praxeology, but was so confused that he dismissed the first of these concepts as merely of “verbal interest,” when the synthetic nature of any praxeological theorem ought to be a straightforward consequence of his epistemology.

This confusion, or lack of interest in the analytic versus synthetic distinction, mostly likely explains his potentially misleading discussion of Euclidean geometry in Human Action, as we have seen in the passage above (Mises 2008: 38).